DETERMINANTS OF RULE OF LAW IN NORTHERN AND WESTERN EUROPE
Saad Buba1, Suryati Ishak1, Muzafar Shah Habibullah2 & Zaleha Mohd Noor3
1, 2, 3Department of Economics, Faculty of Economics and Management, University Putra Malaysia
Corresponding author’s Email:
ABSTRACT
This study provides evidences on the determinants of the quality of rule of law in Europe. The selection of the determinants were made based on the criteria used by Alonso and Garcimartin in identifying these factors. Dataset for 17 countries of the Nordic and Western Europe were employed. The results obtained in the estimated model using pooled mean group (PMG) allow us to pull some remarkable inferences. Firstly, education attainment appeared to have positive influence on rule of law. Secondly, income inequality and economic growth revealed significant effects on the quality of rule of law and finally, trade openness deteriorates the quality of rule of law.
Keywords: Rule of law; Economic growth; pooled mean group; Nordic and Western Europe.
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1. Introduction
The amount of inputs and their efficiencies are the main things to consider in identifying the causes of development. In principle, the theory of modern growth also responds to this conception. Contrary to this idea, a new perception, necessarily compatible emerged in previous years. This perception claims the relevancy, which normative framework and governance (rule of law) have in enhancing development. The rule of law (institutions) defines incentives and penalties, shapes social behaviour and articulates collective action, thus conditioning development. Previous empirical studies have over the years supported this relationship, (See for example, Rodrik, et al., 2004; Acemoglu, et al., 2005; Varsakelis, 2006; Alonso and Garcimartin,
2013).
It is not sufficient, however, to acknowledge from the viewpoint of economic policy that institution (rule of law) do matters. Identifying the determinants of rule of law is also crucial.
This is because implementing policies meant for building better rule of law is equally an important task. Yet, empirical study is scanter in this area and its conclusions are less tenable; mainly due to difficulties faced by the empirical work. In spite of this difficulty, various studies attempted to identify the macroeconomic variables that determine institutional quality. Some of the studies have sought for these determinants in historical or geographical features that are beyond the reach of governments and societies. These variables often lose consequence when they are controlled for level of development. Several other researches have explained institutional quality (disregarding rule of law in particular as an indicator) in terms of its determinants more directly related to economic and social options such as income distribution, international openness or education, (Alonso and Garcimartin 2013).
The current paper gives corroboration about the determinants of the quality of rule of law in the Northern and Western parts of Europe. Variables such as real GDP per capita growth, level of education attainment, income inequality, trade openness and trade liberalisation were considered as potential determinants for the study. The remainder of this paper is organised in the following manner. Section 2 identifies the variables, supposedly describe the quality of rule of law, in section 3, we develop the methodology of the study, section 4 presents the results and discussion on the contribution of each determinant. The main conclusion is finally considered in section 5.
2. Determinants of Rule of Law
Most of the previous studies have focused on the determinants of institutional quality (governance as a whole), however, few studies have focused on the determinants of the six indicators of governance, see for example, Easterly, et al., (2006), Kandil (2009). These studies did not focused on Europe. A study undertaken by Alonso and Garcimartin (2013) has considered variables such as level of development, income distribution, tax system and level of education to examine how they determine the quality of institutions in various countries across the world. The empirical findings of the study suggest that the determinants of institutional quality are within the reach of the government; level of development is positively associated with institutional quality, income distribution determines institutional quality. A sound tax system is also correlated positively with institutional quality. Lastly, level of education is also an important determinant of institutional quality. Siba (2008) has considered various factors as having the ability to determine institutional quality in Sub-Saharan African countries. These factors are;
State legitimacy, foreign aid dependence, variability of aid and checks and balances between executive and legislative and freedom of press. The empirical findings of the study show that State legitimacy determines the quality of institutions in Sub-Saharan African countries; that is to say a vertical State legitimacy has a positive and significant correlation with rule of law as a proxy of institutional quality. The result of the study also revealed that post-independence factors such as reliance on foreign aid, weakens institutional quality by making rule of law difficult in the society. This finding is consistent with the justification that mere anticipation of foreign aid destructs institutional quality. However, variation of aid opposes the negative effects of aid dependence on rule of law. Checks and balances between executive and legislative of government as well as freedom of press and media yield better quality of institutions.
De Groot, et al., (2004) have found that a better quality of institutions have a tendency to correspond with more trade. An overall increase in institutional quality will cause an increase in bilateral trade with an assessed growth of 30-44%. The paper uses gravity model approach to examine the relationship between institutions and trade flows. Factors such as trade policy, geographical vicinity, language among others are used as explanatory variables. They found that countries having similar institutional quality frameworks promote bilateral trade among them by 13 percent on average. This will in turn reduces transaction costs. They conclude that institutional quality positively, substantially and significantly affects bilateral trade flows. Kandil
(2009) investigates the determinants of institutional quality based on the six indicators of governance. The major factors considered by the study as potential determinants are economic freedom measured by the Cato Institute and Heritage foundation, real GDP per capita, degree of openness, risk rating and indicators of policy quality. The study covers the Middle East and North African (MENA) countries. The findings of the study revealed that five out of six measures of institutional quality, positively and significantly affect real GDP per capita in the MENA region. However, the effect is negative on private credits and private investments growth.
According to the author the study provides how institutions have affected the performance of macroeconomic indicators. The inference drawn is that improving institutional quality would share the benefits growth and improve the performance of macroeconomic indicators in MENA countries.
Social cohesion, institutions and growth, is a study by Easterly, et al. (2006). The study found that social cohesion determines the quality of institutions endogenously and in turn causes the growth of an economy. The measures used for social cohesion by the study in presenting these evidences are income inequality and ethnic fractionalization. The findings confirmed that more fractionalized societies are characterized by poorer rule of law, and that high quality of institution is correlated with low level of income inequality. Torgler and Schneider (2009) have examined the relationship between tax morale, institutional quality and the shadow economy using multivariate analysis. The authors found, after controlling for possible factors that higher tax morale and a higher institutional quality lead to a reduction of shadow economy.
3. Methodology
The method of estimation used by this study in achieving the objective of the study is the Pooled Mean Group (PMG) estimator developed by Pesaran et al., (1999). Prior to estimation of the PMG, preliminary tests, such as the panel unit rootis conducted. In addition,. On the dataset, the rule of law index was taken from the World Bank’s World Governance Indicator (WGI), while data on income inequality and real GDP per capita, Trade openness and trade liberalisation were taken from the World Bank’s World Development Indicator (WDI). Finally, data on Education attainment, measured by Human capital index based on years of schooling per person was taken from Penn World Table 8.1 and WDI.
4. Finding & Discussion
In this section, the results of our findings are presented and the discussion on the findings is made. It started with discussion on the results of panel unit root test; three kinds of panel unit root tests have been conducted, which revealed that not all the variables under study, are stationary at level (I(0)), but all are stationary at first differenced, (I(1)) as indicated by the p-values. Table 1 below reported the results of the panel unit root tests both at level and at first differenced.
Table 1 Results of Panel unit root test
Level: I(0) X ~ I(1) / First Differenced I(1) 4X ~ I(0)Variable / Statistics / Values / P-values / Conclusion / Values / P-values / Conclusion
Ineq / Levin, Lin, Chu t
Im, Pesaran, Shin
ADF Fisher / -3.2698
-1.9183
46.0156 / 0.000
0.027
0.007 / I(1)
I(1)
I(1) / -10.682
-9.9389
158.700 / 0.000
0.000
0.000 / I(0)
I(0)
I(0)
RoL / Levin, Lin, Chu t
Im, Pesaran, Shin
ADF Fisher / -0.6967
0.0776
39.3342 / 0.230
0.531
0.243 / I(1)
I(1)
I(1) / -4.2003
-6.3077
105.757 / 0.000
0.000
0.000 / I(0)
I(0)
I(0)
gwth / Levin, Lin, Chu t
Im, Pesaran, Shin
ADF Fisher / -8.7041
-7.3313
114.732 / 0.000
0.000
0.000 / I(1)
I(1)
I(1) / -15.224
-14.214
227.695 / 0.000
0.000
0.000 / I(0)
I(0)
I(0)
educ / Levin, Lin, Chu t
Im, Pesaran, Shin
ADF Fisher / -7.7037
-3.5466
72.2462 / 0.000
0.000
0.000 / I(1)
I(1)
I(1) / -2.4240
-1.2225
50.6380 / 0.007
0.110
0.033 / I(0)
I(0)
I(0)
T/lib
T/op / Levin, Lin, Chu t
Im, Pesaran, Shin
ADF Fisher
Levin, Lin, Chu t
Im, Pesaran, Shin
ADF Fisher / -9.1684
-3.2406
62.6548
-2.3260
0.8091
25.120 / 0.000
0.000
0.002
0.010
0.790
0.865 / I(1)
I(1)
I(1)
I(1)
I(1)
I(1) / -8.6612
-7.8139
123.89
-14.946
-13.155
205.092 / 0.000
0.000
0.000
0.000
0.000
0.000 / I(0)
I(0)
I(0)
I(1)
I(1)
I(1)
Diagnostic check is also conducted before the main long run estimate is made, so as to validate the dataset of the variables. Multicolinearity is the problem that has been diagnosed; it occurs when the exogenous variables became correlated to one another. This problem (multicolinearity) is detected by having the value of variance inflation factor (VIF) less than 10. Table 3 reports the result of the multicolinearity test. All the variables are having their respective VIF less than 2, at average, the value of the VIF for all the 5 exogenous variables is 1.14. This value is too low but too sufficient to disallow the occurrence of multicolinearity.
Table 2. Results of multicolinearity
Variables / Variance inflation factor (VIF) / 1/VIFRgdp / 1.14 / 0.8755
Ineq / 1.14 / 0.8782
T/lib / 1.24 / 0.8061
Educ / 1.14 / 0.8798
Open / 1.03 / 0.9677
Mean VIF / 1.14
The result of the long run effects of the independent variables on rule of law. The estimation is in three different model, represented by columns 1 – 3.
Table 3. Result of PMG Estimation
Long run Coefficient / Column 1 / Column 2 / Column 3Rgdp / -0.014***
(0.005) / -0.012***
(0.002) / -0.008***
(0.0015)
Educ / 1.098***
(0.183) / 1.056***
(0.057) / 1.869***
(0.222)
Ineq / -0.272***
(0.055) / -0.331***
(0.006) / -1.471***
(0.088)
T/lib / ------
------/ -0.010***
(0.001) / -0.064***
(0.006)
Open / -0.150***
(0.042) / ------
------/ -0.190***
(0.013)
ECT / -0.414***
(0.065) / -0.556***
(0.185) / -0.245***
(0.065)
Hausman LRH Test / 0.8911 / 0.9329 / 0.9944
Observation / 230 / 230 / 230
Countries / 17 / 17 / 17
Note: dependent variable is ROL, ECT= Error correction Term, LRH= long run homogeneity, *** is 1%, significance levels, standard errors in ()
Table 3 revealed that economic growth, measured by percentage growth in real GDP per capita income reports a negative coefficients in the area of study. This means that a growth in real GDP per capita income gives a negative impact on the quality of rule of law. Although, a single percentage point increase in per capita real GDP induces a less than 0.01 percent decrease in the quality of rule of law. For instance, column 3 revealed negative coefficients of -0.008. This result does not validate the expectation of this study and the findings of Alonso and Garcimartin (2013). However, according to Dam (2007), causation normally, to some extents, runs from institution to growth and not bidirectional. Dam (2007) argued that it is either economic crises or expansions of market or both that usually call for an appropriate and strong forces for legal reform, and not economic growth or development.
This can be explained to the fact that governments of countries give much attention to strong rule of law, during economic crises or market expansions, and, less during economic boom, growth or development. In the case of Europe, therefore, economic growth impacts less towards improvement of the quality of rule of law in the continent. Thus, this study corroborates the arguments posed by Dam (2007) that rule of law induces growth rate but not vice versa, and, that legal reforms are given maximum attention during economic crises.
Years of education attainment in the regression have revealed a positive coefficient, indicating that the variable, positively impacts the quality of rule of law in Europe. The results report that an increase in the level of education attainment increases the quality of rule of law. For instance, column 2 reported that a 1 percent increase in level of education attainment triggers a 1.056 percent. This finding validates the expectation of this study and the earlier findings of Evan and Rauch (2000). The study therefore, confirmed that high level of education attainment among Europeans strengthens the quality of rule of law in the regions, as more people becoming more educated, they realize the importance of rule of law and abide by it.
Income inequality Coefficients revealed a negative sign, to show that it related negatively with the quality of rule of law. Result in column 1 reports that a 1 percent increase in income inequality, leads to a 0.272 percent decrease in the quality of rule of law, and the impact is significant at 1 %. This finding is in line with the expectations of this study and the earlier findings of Glaeser, et al. (2003). According to Glaeser, et al. (2003), the actions of legal, political and regulatory institutions is undermined by the rich and the politically dominant people aimed at their own advantage. This study therefore, confirmed that inequality of income distribution is negatively and significantly associated with the quality of rule of law in the Nordic and Western countries.
8. Conclusion and Future Recommendation
This study examined the determinants of rule of law in the Nordic and Western Europe, using PMG estimator proposed by Pesaran, et al. (1999). Variables such real GDP, income inequality, education attainment, trade liberalisation and trade openness were used the determinant based on the criteria applied by Alonso and Garcimartin (2013). Education attainment is the only variable appeared to have positive impact on the quality of rule of law in the 17 selected countries of Northern and Western Europe. This means that the more Europeans attain higher level of education, the more they become mindful of the law and order and abide by them.
The impact of economic growth is found to be negative and significant on rule of law. Although, the outcome is contrary to the expectation of this study, this is due to the fact that during economic progresses, legal reforms will be given less consideration, and much more will be given during economic crises. Income inequality revealed a negative effect on rule of law in Northern and Western Europe, and this means that income inequality undermines rule of law in these countries. Trade liberalisation measured by tariff reduction is found to have a positive impact on rule of law. Trade openness on the other hand, measured by the percentage of trade to GDP is found to have a negative effect on the quality of rule of law. Even though, openness as a contributing factor to economic growth, is expected to have a positive impact on rule of law, nevertheless, positive legal reform process takes place, mostly during economic crises.
These findings do not permit us to make an extensive statement on other regions of the world as the data and the sample size is constricted to 17 countries in Northern and Western Europe. Therefore, further studies on other regions are hereby recommended.
Acknowledgement
This paper is under scholarship of the University Putra Malaysia.
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